Kratzmann's Hardware Pty. Ltd. v. Federal Commissioner of Taxation.

Members:
Ryan J

Tribunal:
Supreme Court of Queensland

Decision date: Judgment handed down 22 March 1985.

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Ryan J.

This is an appeal by a taxpayer, Kratzmann's Hardware Pty. Ltd., against an assessment to income tax for the income year ending 30 June 1980.

The notice of objection claimed that the assessment should be reduced by the exclusion from the assessable income of an amount of $40,383. A schedule to the taxpayer's return revealed that in February 1980 the taxpayer sold 800 shares in Central Pacific Minerals N.L. which were acquired during the year ended 30 June 1971. The profit on sale was the difference between the sale price of $40,795 and the cost of the shares, $412. It was stated in the schedule that when these shares were acquired they formed part of the taxpayer's share trading stock. However, the taxpayer ceased to be a share trader on 1 July 1978, and the shares previously comprising trading stock had been held since that date as investments. The objection was disallowed, and the appeal is made against the decision to disallow the objection.

The appellant was incorporated about 1954, and commenced share trading about 1969. It had extensive share dealings in the years 1970 and 1971 and it was admitted that it was a share trader in those years. However, evidence was given by Mr Kratzmann, the managing director of the appellant company, that as from 1973 or 1974 the company intended to hold the shares in Central Pacific Minerals N.L. indefinitely. I accept that evidence as correct. The company continued, however, to lodge income tax returns for the years 1973 to 1978 in which it set out what were designated as ``speculative shares on hand - at market value''. Included in these were shares in Central Pacific Minerals N.L. However, in the return for the income year ending 30 June 1979, the shares are revalued at cost, and a schedule to that return records that as from 1 July 1978 all shares held by the taxpayer were held purely as investments.

After the income year ended 30 June 1972 the only shares sold by the appellant company were some 400 shares in Associated Australian Resources N.L. and the 800 shares in Central Pacific Minerals N.L. which were sold in February 1980. No shares have been sold by the appellant since February 1980. Mr Kratzmann gave evidence which was not challenged that the sale of the shares in Associated Australian Resources occurred pursuant to a take-over of that company by another company. He said further that the sale of the Central Pacific shares was made to eliminate an overdraft of $40,000 which an associated company, Kratzmann Acacia Ridge Pty. Ltd., had with the Commercial Bank of Australia. He said that sale of the shares was the easiest way to find the money at the time. I accept his evidence in this regard. He admitted that the market price of those shares had remained around the price he paid for them, but they had risen in the year preceding the sale and continued to rise after the time of sale. The price of the shares appears to have risen in 1979 from below $10 to $53, which was the price at which they were sold.

On 29 June 1978, a resolution was passed by the directors of the appellant company that the company cease business as a share trader from 1 July 1978 and that all shares held by the company at that date be held purely as investments for the future. It was explained by Mr Kratzmann that his accountant (now deceased) had advised him that it was pointless to continue valuing the shares each year at market value when the company had no intention of selling the shares and when it was not carrying on any trading operations. It was suggested in cross-examination of Mr Kratzmann that no such resolution was passed on 29 June 1978, but I accept his evidence that it was.

The shares in Central Pacific Minerals N.L. which were sold were acquired in the years 1970 or 1971, or acquired as a result of a rights issue in respect of those shares in December 1978.

There is no doubt on Mr Kratzmann's evidence that the appellant was engaged in the business of share trading in 1970 and 1971, that it bought the shares for the purpose of selling them at a profit and that upon acquisition they became part of its trading stock. It was, however, claimed on behalf of the taxpayer that the profit arising from the sale of the shares in Central Pacific Minerals N.L. should not be included in its assessable income since it was a profit arising from the realisation of a capital asset.

There is no reason in law why a trader should not appropriate stock in trade as a fixed capital asset:
British Borneo Petroleum Syndicate Ltd. v. Cropper (1969) 1 All E.R. 104 at p. 108. In
Danmark Pty. Ltd. & Forestwood Pty. Ltd. v. F.C. of T. (1944) 7 A.T.D. 333,

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ATC 4140

it was held by Latham C.J. and Williams J., with Starke J. dissenting, that a company which had originally as its principal business the buying and selling of company shares, but which had abandoned that policy and had adopted a resolution that the company's assets should not be regarded as stock in trade but as investments, was engaged in realising investments when it sold certain shares which had been held by the company from the beginning. The only point on which the members of the High Court were in disagreement was as to whether there was sufficient evidence that the trading stock had been converted into investments of a capital nature.

In this case, I am satisfied that such conversion is established. I have regard in coming to this conclusion not only to the resolution but also to the fact that no sales of shares have taken place since 1972 except the two parcels already mentioned. I have concluded that the sale of the relevant shares was a realisation of a capital asset to pay off a bank overdraft, and not a trading in shares. The sale of those shares was made because the market was favourable, but that does not lead me to conclude, in view of the lack of sales since 1972, that the taxpayer was still engaged in trading in shares and was only awaiting better times to sell them.

The question which then arises is whether the taxpayer is nevertheless liable to have an amount included in its assessable income pursuant to sec. 36(1) or 26(a) of the Income Tax Assessment Act (the Act).

Section 36(1) so far as relevant provides:

``Subject to this section, where -

• (a) a taxpayer disposes by sale... of property being trading stock...,
• (b) that property constitutes or constituted the whole or part of the assets of a business which is or was carried on by the taxpayer; and
• (c) the disposal was not in the ordinary course of carrying on that business,

the value of that property shall be included in the assessable income of the taxpayer

...''

In this case, the appellant had discontinued its business of share trading at the latest by 1 July 1978. It had, however, previously been involved in that business, and the relevant shares were trading stock of that business. On these facts, I consider that I am bound by the decision in
F.C. of T. v. Murphy (1961) 106 C.L.R. 146 to hold that the Commissioner acted correctly in including the proceeds of sale of the shares in the appellant's assessable income. The court stated (at p. 154):

``In sec. 36 the connexion of property with a business of the taxpayer goes to the root of the reasoning upon which the provision is constructed; but it is reasoning which is valid whether the carrying on of the business by the taxpayer be current or past... For the case where a disposal occurs after the taxpayer has gone out of the business, sec. 36 insists upon the former connexion of the property with the business by describing it as having constituted the whole or part of the assets of a business which was carried on by the taxpayer.''

Here, the property disposed of constituted part of the assets of a business of share trading which was carried on by the taxpayer. The disposal was not in the ordinary course of carrying on that business. The property disposed of was not held as trading stock of the taxpayer at the time of disposal, and it was argued in this case, as it was in F.C. of T. v. Murphy, that it could not be said that the condition in para. (a) of sec. 36(1) was fulfilled, since that requires that the disposal is of property ``being'' trading stock. The answer given in F.C. of T. v. Murphy was that the first limb of the definition of trading stock in sec. 6 of the Act ``provides an historical test, making decisive the purposes for which the taxpayer produced, manufactured, acquired or purchased the property'', and in para. (a), the word ``being'' merely describes the property as presently possessing a particular history. The property sold by the taxpayer in this case can be accurately described as being property which was acquired by the taxpayer for the purpose of sale.

It was submitted for the taxpayer that F.C. of T. v. Murphy was distinguishable. It was said that in that case, the trading stock could be categorised at the time of sale as being stock of the business, whereas here the connection with the business was severed. But this argument is answered by a reference to para. (b), which is satisfied if the property constituted part of the

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ATC 4141

assets of a business which was carried on by the taxpayer. No degree of severance can change the fact that the property at one stage was an asset of a share trading business which was carried on by the taxpayer.

The appellant pointed out that the shares were brought to account in the income year ended 30 June 1979 at purchase price. In the schedule to that return, it claimed a net loss upon a revaluation of the shares at cost. That did not however in any way prevent the application of sec. 36(1) of the Act upon a disposition of shares.

The Commissioner relied also on the first limb of sec. 26(a) of the Act. It was argued on behalf of the taxpayer that that provision could not apply where property was acquired as part of a continuing business. Reference was made to statements in judgments of members of the High Court that sec. 26(a) ``brings to tax profits which because of the singular or isolated transactions out of which they arose might not otherwise be income of the taxpayer'':
F.C. of T. v. McClelland (1969) 118 C.L.R. 353 at p. 358 (per Windeyer J.); that sec. 26(a) ``is intended to deal with transactions which are entire in themselves and do not form part of a more extensive business'':
Investment & Merchant Finance Corp. Ltd. v. F.C. of T. 71 ATC 4140 at p. 4142; (1971) 125 C.L.R. 249 at p. 255 (per Barwick C.J.); that sec. 26(a) does not ``aptly apply to the particular dealings constituting, in total, the carrying on of a business'': Investment & Merchant Finance Corp. case at ATC p. 4147; C.L.R. p. 264 (per Menzies J.).

It may be concluded from these statements that sec. 26(a) could have no application to the receipts arising from trading in shares by the taxpayer so long as it continued in the business of share trading. Those receipts would be brought to tax pursuant to the provisions of the Act relating to trading stock or under sec. 25(1). But in my opinion while the effect of a successful claim, that the relevant shares ceased to form part of the taxpayer's trading stock and were transmitted into a capital asset, is that they no longer are assessable under sec. 25(1), they do properly fall to be assessed pursuant to the first limb of sec. 26(a). It was central to the taxpayer's case to establish that the amount received upon the sale of the shares was not a receipt in the ordinary course of its business. Having done that, it has removed the difficulty which otherwise would prevent the application of sec. 26(a). That provision does not apply to individual transactions forming part of a more extensive business, but it is not to be read as though it required not only that property should be acquired for the purpose of profit-making by sale, but also that it should not be acquired as part of a continuing business.

In this case, Mr Kratzmann readily admitted that the shares were acquired by the taxpayer for the purpose of profit-making by sale. Profit arose from the sale by the taxpayer of that property. That profit is therefore properly included in the assessable income of the taxpayer.

I dismiss the appeal with costs.